Whiffs of interest rate cuts in Brazil

March 30, 2016

Brazilian Central bank chief Alexandre Tombini leaves the Economic Affairs Committee of the Senate in Brasilia December 16, 2014. Tombini repeated on Tuesday that the bank's forex intervention program has met its goals and that the current stock of swaps has fulfilled businesses' demand for currency protection. The comments raised doubts about the continuity of the bank's currency intervention into 2015. Tombini clarified, however, that the bank is currently deciding on new terms for the program that will take effect as of next year. His comments were not enough to ease investors' concerns. The real weakened further after he spoke, trading at 2.781 per dollar, nearly 2 percent weaker, as the market expected more details on the program that currently sells $200 million worth of currency swaps per day. REUTERS/Joedson Alves (BRAZIL - Tags: BUSINESS POLITICS HEADSHOT) - RTR4I9C8 As impeachment of President Dilma Rousseff grows more likely, chances are rising that Brazil’s central bank may also go under new management in a matter of months.

But regardless of whether central bank chief Alexandre Tombini stays in office for long, prospects of interest rate cuts have found their way back on investors’ radar.

Brazil’s economy is locked in its worst recession in decades, possibly in more than a century. And yet Brazil’s central bank since last year has stubbornly held the benchmark Selic rate at a near decade-high of 14.25 percent, one of the highest of in the world.

The bank’s logic goes that along with the punishing economic downturn, restrictive rate policy will also help force inflation, currently at 10 percent, down sharply.

Many economists have warned that cutting rates in such an environment could backfire, spurring even higher inflation, as happened in the 2011 cycle Tombini started himself.

But as the exchange rate recovers, fueled by market hopes of Rousseff’s impeachment, inflation expectations have started to subside.

So far, Tombini and other central bank directors have reiterated they are not considering rate cuts. But the central bank’s quarterly inflation report due on Thursday could change the tone ever so slightly.

“If projected inflation is at or below 6.50 percent by end-2016, and/or in the close vicinity of the 4.50 percent target by end-2017, the central bank … could start signal and set the stage for rate cuts in the near horizon. However, if projected inflation remains visibly above the 4.50 percent target by end-2017, the bank will likely continue to signal near term rate stability,” wrote Alberto Ramos, head of Latin America economic research at Goldman Sachs.

The central bank’s official 2016 inflation forecast in the last report was 6.2 percent. But that was based on estimates for a weaker exchange rate (3.90 reais to the U.S. dollar) and a more mild economic contraction (1.9 percent drop) than appears likely now. Both are likely to be revised in a way that could allow for lower inflation forecasts too.

One month ago, a Reuters poll showed many economists, although not a majority of them, expected the central bank to start trimming the Selic rate by the end of the year. Recently, though, rate futures have started to price in a one in four possibility of a rate cut right at the next meeting, later this month.

But not everyone is convinced.

Bradesco’s chief economist Octavio de Barros noted that inflation was stronger than expected in the first months of the year, which should offset the impact of forecast revisions. He reckons the that latest 2016 inflation forecast will remain stable.

Itau Unibanco’s economists are more pessimistic, expecting a slight increase in the bank’s inflation view.

“The central bank will likely continue to indicate no room for rate cuts in the very short term. We expect an easing cycle to begin in the second half of this year,” according to Itau’s economists led by Ilan Goldfajn.

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